Financial Instruments for Energy Markets
Energy Day, Stockholm School of Economics, SITE December 2014
Laurent Cheval
Head of Nordic and Fuel Origination
Business Division Asset Optimisation and Trading
Key questions for discussion today
•
What are some of the commercial/financial risks involved in the energy sector ? (taking the electricity sector as an example)
•
How does an utility operate and manage these risks? (taking Vattenfall as an example)
•
What are the tools/products that are available to market players (producers, investors and customers) for managing these risks?
•
How can we expect the energy markets to evolve? What new risks, needs and products may arise?
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General overview of enterprise risks for an integrated utility company
Focus on
financial risks for today’s discussion
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Financial risk (short- to medium-
term)
Risks in operational assets and infrastructure, and personnel and organisational risks (short- to long-
term)
Risk for changes in political policies, changes in public opinion, changes in regulations and risk in choice of technology
(medium- to long-term)
Financial riskOperational riskStrategic risk
Examples of commercial / financial risks along the value chain showing the high diversity of risks
• Electricity price risk
• Volume risk - precipitation risk
• Electricity price volatility and time spread risk
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Production
Optimisation
Distribution
Sales
Customer / third party
Traditional value chain
Hydro Power Plant
Coal/Gas-fired power plant
Fuel Sourcing
Fixed price
(Swing) contract
Aluminium producer
Case examples Main commercial / financial risks
• Electricity price risk
• Volume risk - (partly driven by temperature risk for Nordic B2C customers )
• Green Dark Spread risk (Power, Coal, FX, CO2)
• Clean Spark Spread risk (Power, Gas, CO2)
• Time spread risk
• Transportation / Freight risk
• Aluminium-Power spread risk
These risks are significant considering the high volatility of the underlying commodities
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5
-40 -30 -20 -10 0 10 20 30 40
2015 2014
2013 2012
2011
-40 -30 -20 -10 0 10 20 30 40
2016 2014
2012 2010
2008 2006
2004
Clean Spark Spread (German Power;
Zeebruge Gas; 55% efficiency), EUR/MWh
Green Dark Spread (SYS Nordic Power; API2 coal, 38% efficiency), EUR/MWh
0 20 40 60 80 100
Nordic Power, System Price , EUR/MWh
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
How is an utility company structured to manage these risks? Vattenfall as an example
• 100%-owned by the Swedish state
• Main markets are: Nordics, Germany, Netherlands and UK
• Main products are: Electricity, Heat, Gas
• Fully integrated utility, works in all parts of the value chain: Production, Distribution, Sales and Trading
• Diversified production portfolio: Hydro, Nuclear, Coal, Wind, Biomass and Gas
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CEO
Nordic Continental/UK
Corporate Staff Functions Asset Optimisation
and Trading
CFO Functions
Vattenfall in a nutshell Vattenfall’s organisation
• Regional organizations, but one centralized cross-regional commercial Business Division (Asset Optimisation and Trading - AOT)
• Most of the commercial risks are managed centrally within BD AOT.
Asset Optimisation & Trading - activities and markets
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Hedging, production planning and dispatching of Vattenfall’s generation capacities (coal, hydro, gas, nuclear, wind, biomass)
2.
Providing Vattenfall with market access to all relevant commodity wholesale markets (physical and financial): power,
gas, coal, oil, biomass, carbon credits, freight, green certificates3.
Sourcing, transporting and storing of physical commodities
4.
Developing and marketing of tailored, non-standard products to
customers/third parties
5.
Portfolio management, market access and consulting for industrial
customers and municipal utilities
6.Proprietary trading
Power Markets Gas Markets Locations Trade floors Energy Exchanges Amsterdam
Warsaw Hamburg
Copenhagen
Stockholm
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Overview of the “financial” tools/products available for market participant to manage these risks
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Standard products Tailor-made products/solutions b
a
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Mainly traded over exchange (e.g.
Nordpool OMX Nasdaq, ICE)
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Often possibility to clear trades via a Clearing House if traded Over The Counter (OTC)
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Often reasonable liquidity
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Not necessarily financial products, but quite often with physical
delivery, depending on commodities and markets
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Solely traded Over The Counter (OTC)
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Very much tailored made products fulfilling a counterparty’s or
customer’s specific needs/risk profile.
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Increasing demand for these kind of products/solutions
The delineation between standard or tailor-made products is partly based on market liquidity/maturity and differs
significantly between commodities and markets
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Main Standard Products 3a
Fixed price products Standard options
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Different type of options:
European, (American, Asian)
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Option (not obligation) to buy or sell at a predefined price
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Option premium to be paid to the option provider
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Typically used for trading volatility and securing cap or/and floor prices
Examples of products available on NordPool (OMX) for Nordic Power
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Financially settled baseload and peakload forwards/futures for System Price and EPADs (price areas) with weekly, monthly, quarterly and yearly delivery periods.
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European options for Baseload power with quarterly and yearly delivery periods
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3 main product types: forward, futures, swaps depending on:
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Settlement: financial or physical
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Margining: daily, monthly or none (only at delivery)
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One party takes the fixed price
risk on behalf of the other party.
Example of tailor-made products/solutions (1/2) 3b
Virtual Power Plant (VPP) or Virtual Hydro Plant (VHP)
• Close to “perfect” hedge to the commercial risks of a power plant
• Generally, a purely financial virtual power plant decoupled from the actual physical dispatch of a real power plant, but designed to mimic it to the best extend.
• For VHP, possibility to have real (stochastic) water inflow to hedge the weather risk
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• Standard products are not sufficient to properly hedge a coal fired or hydro power plant, in particular the following embedded risks:
− Weather risks (in the case of Hydro power plant)
− Profile risks (volume time price risks on hourly basis)
− Option/flexibility value
− Green Dark Spread risk (timing of hedging of the different legs) (in the case of a Coal-fired power plant)
• Need for more sophisticated/tailor made hedging products
GDS Swap
• One party provides a fixed baseload or profiled Green Dark Spread to the power plant owner for a predefined period.
• Relatively efficient hedge for heat driven CHP or not very flexible coal-fired power plant
Example of tailor-made efficient hedging products
Example of tailor-made products/solutions (2/2) 3b
Customer’s tailor-made package
• Purchase of the wind farm output
− Wind Power Purchase agreement (PPA), including imbalance risk
− Purchase (& hedging) of Electricity Certificate
• “Transfer” (financially speaking) the power to where the customer
consumes it, i.e. hedging of cross- border power price spreads
• Power supply contract at
consumption locations including imbalance management
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• Standard products are not sufficient to properly fulfil the specific needs of certain customers
• Example of a customer with:
• Different sites across Europe where electricity is consumed
• Corporate branding strategy for only
consuming green electricity and being self- sufficient from a electricity supply
• Typically, customer would lease, purchase or construct wind farms in a country/ location where there are good financial pre-requisites and good wind statistics
• Willingness to transfer the electricity
produced by wind farms to the consumption sites
• Need for a tailor-made solution for fulfilling the customer’s wishes/ambition
Example of tailor-made solution
How is the energy market likely to develop?
Implications in terms of products/needs 4
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Weather derivatives or embedded structures hedging the weather risks
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Increased focus and liquidity on the very short-term market (intraday, balancing market)
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More tailor-made products/solutions
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Wind or Solar PPA packages
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Wholesale Market Access Services
provided to customers/third parties (Direct Marketing)
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Demand Response Products
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Aggregation of Distributed Production.
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Trends in the energy markets
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Markets increasingly global and interconnected
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Rising share of intermittent production (renewables)
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Driving short-term power price volatility
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Moving decision closer to real time
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Increasing weather risk exposure to producers
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A new energy landscape with
increased decentralized production (“Prosumer”) requiring eventual grid upgrades
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Uncertain regulation (CO2, financial regulations)
Examples of potential new products or existing one with increasing interest
Thank you
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